A Rule Of Reason For Vertical Price Fixing - Part I

This first installment of a two-part article examines the legal underpinnings of the Supreme Court's recent rejection of an antitrust rule against resale price maintenance ("RPM"), in place for 96 years.

One of my most vivid memories of law school remains the class that my antitrust professor (and formerly the DOJ's top antitrust enforcer), Bill Baxter, spent dismembering the Supreme Court's 1911 decision in Dr. Miles Medical Co. v. John D. Park & Sons , which held vertical price-fixing (RPM agreements between a supplier of products and a downstream distributor or retailer) to be per se unlawful under the Sherman Act. On June 28, 2007, the views expressed by commentators such as Professor Baxter and by Justice Holmes, who dissented in Dr. Miles - i.e. , that a manufacturer in a competitive market should have the right to control how its products are distributed - were finally vindicated. In a 5-4 decision in Leegin Creative Leather Products, Inc. v. PSKS, Inc. , 127 S. Ct. 2705 (2007), the Court held that minimum RPM agreements, like most other competitive restraints (other than cartel behavior and tying arrangements), are appropriately analyzed under the antitrust rule of reason - i.e. , courts must weigh all of the circumstances of the restraint, and the restraint's history, nature and effect in the market involved, in order to ascertain whether anti-competitive effects outweigh any pro-competitive benefits.

As summarized below, the Leegin decision is noteworthy on a number of levels - as the latest retrenchment of the per se rule's application to vertical restraints; as the overturning of a 96-year-old Dr. Miles precedent, with all the significance that Court-watchers would read into that event; and as part of a remarkable period of antitrust activity for the Court recently - namely one of seven antitrust decisions handed down in the past four years - that, to the likely consternation of the district courts, has done away with some significant bright-line rules. As will be discussed in the second part of this article, the decision also has significant practical repercussions on distribution and pricing policies in the marketplace, as well as potential ripple effects in state antitrust law enforcement.

Ironically, the landmark Leegin case arose in a quite banal factual setting. Leegin is a manufacturer and distributor of small leather goods and accessories sold under the "Brighton" brand name to over 5,000 retail outlets, and had a policy of refusing to sell to retailers that discounted its goods below suggested prices. PSKS was one such retailer and was terminated by Leegin. PSKS then sued Leegin, claiming it had violated the antitrust laws by entering into vertical agreements with its retailers to set minimum resale prices. The jury found for PSKS, and the Fifth Circuit Court of Appeals affirmed, specifically refusing to apply the rule of reason to Leegin's arrangement on the ground that the practice was per se unlawful under Dr. Miles . Thus, Leegin was not allowed to present to the jury any pro-competitive justifications for its policy.

When the Supreme Court granted certiorari , many antitrust lawyers undoubtedly assumed the result to be a foregone conclusion. After all, the Court had nibbled away at the Dr. Miles rule for years, beginning with the body of law that developed from the 1919 decision in United States v. Colgate , holding that a supplier has the right to announce a minimum price at which it expects dealers to resell its products and to refuse to do business with those who do not comply. Generally, such conduct was considered unilateral action by the supplier rather than an agreement, although it was complicated by issues of supplier coercion, other supplier efforts to achieve compliance, and the relevance of pricing complaints from other dealers.

In the 1977 Continental T.V., Inc. v. GTE Sylvania, Inc. decision, the Supreme Court held that vertical non-price restraints ( e.g. , territorial or customer restraints within a brand) thenceforth would be subject to the rule of reason. The GTE Sylvania opinion stressed that although such practices restrain intrabrand competition, so long as a market is competitive, they stimulate interbrand competition - which the Court declared to be the "primary concern of the antitrust laws" (a refrain echoed four times in the Court's 2006 Robinson-Patman Act decision Volvo Trucks N.A., Inc. v. Reeder-Simco GMC Inc. ).

In 1984, in Monsanto Co. v. Spray-Rite Service Corp. , the Court made clear that because there exists a fine line in deciding between Colgate -protected unilateral conduct and a per se unlawful RPM agreement, RPM should not be found from mere dealer compliance with a supplier's announced resale pricing policy. Rather, it would be necessary to show that the supplier sought agreement and that the dealer specifically communicated its acquiescence. Four years later, in Business Electronics Corp. v. Sharp Electronics Corp. , the Court further declared that termination of a dealer in response to another dealer's pricing complaint does not constitute RPM unless remaining dealers have agreed with the supplier to maintain prices.

Finally, in the 1997 State Oil Co. v. Khan case, the Court held that maximum RPM would no longer be per se unlawful (but, rather, subject to the rule of reason), because ceiling prices are generally pro-consumer and do not harm competition - either interbrand or intrabrand. No maximum RPM case has since resulted in a finding of illegality.

In short, it seemed likely that the stage was set for the rule in Dr. Miles to be "retired," as the Court termed the fate of its 1948 Conley v. Gibson pleading standard (permitting a complaint to go forward unless it appeared that there was "no set of facts" the plaintiff could demonstrate to support it) in Bell Atlantic Corp. v. Twombly , a 7-2 decision delivered in May 2007. The Leegin vote, however, was closer.

Writing for the majority (joined by Justices Roberts, Scalia, Alito, and Thomas), Justice Kennedy noted that the 1911 Dr. Miles decision relied on two grounds: the "ancient" common-law rule that "a general restraint upon alienation is ordinarily invalid," and the belief that RPM agreements were analogous to conspiracies among competing retailers, which had always been considered per se unlawful. However, the Court declared that the rule against restraints upon alienation was based on real property law that is "extraneous" to the antitrust laws today, and it noted the different economic effects between horizontal and vertical restraints that are perceived in modern antitrust analysis. The two principles underlying Dr. Miles thus no long justified a per se rule.

Justice Kennedy stressed that current economic literature is replete with pro-competitive justifications for a manufacturer's use of RPM. Specifically, vertical restraints within a brand can stimulate competition among manufacturers selling different brands, the "primary purpose" of the antitrust laws. RPM may eliminate intrabrand pricing competition, but it can encourage retailers to invest in services and promotional efforts, aiding a manufacturer in its efforts to compete with its competitors. It also can increase interbrand competition by facilitating market entry for new firms. Further, RPM can give consumers more options to choose from among low-price, low-service brands, or high-price, high-service brands. Without RPM, retail services that enhance interbrand competition might be disincentivized and underprovided because discounters can free-ride on service-oriented retailers and capture the benefits of the demand such services generate.

The Court determined that second-best alternatives to RPM add costs and risks for manufacturers and increase prices for consumers. Specifically, juries may improperly find an agreement from a supplier's otherwise protected unilateral refusals to deal. For this reason, a supplier might refuse to discuss its pricing policy with retailers except through antitrust counsel, or terminate a longstanding customer for minor violations that it will not discuss with the retailer. A manufacturer may vertically integrate, of course, but that may be inefficient and, in doing so, all intrabrand competition downstream would be eliminated. In sum, Justice Kennedy concluded that the per se rule of Dr. Miles :

is a flawed antitrust doctrine that serves the interests of lawyers - by creating legal distinctions that operate as traps for the unwary - more than the interests of consumers - by requiring manufacturers to choose second best options to achieve sound business objectives.

The majority opinion did recognize that RPM may have an anti-competitive effect because it can facilitate a manufacturer cartel or retailer cartel. It also could be abused by a powerful manufacturer to incentivize retailers not to sell the products of smaller rivals, or used by a dominant retailer to force a manufacturer not to sell to innovative or more efficient retailers. Accordingly, RPM's potential anti-competitive consequences should not be ignored. Rather, the pro-competitive and anti-competitive effects in a specific case should be weighed under the rule of reason, and, in so doing, the lower courts are directed to consider: (i) the number of manufacturers using the practice; (ii) the source of the restraint; and (iii) the manufacturer's market power.

Justice Breyer (joined by Justices Souter, Ginsburg and Stevens) dissented, lamenting the Court's "departure from ordinary considerations of stare decisis " and stressing that the Court should respect a 96-year-old precedent that had been the subject of "a century's worth of similar cases, massive amounts of advice that lawyers have provided their clients, and untold numbers of business decisions those clients have taken in reliance upon that advice." It was, however, hardly shocking that the Court would further circumscribe the narrow range of conduct subject to the per se rule under the antitrust laws - particularly minimum RPM. Justice Breyer's language, like that of Justice Stevens in his dissent in Twombly a month earlier ("if Conley 's 'no set of facts' language is to be interred, let it not be without a eulogy") appears to betray a deeper concern about the vulnerability of other precedents, and Roe v. Wade cannot be far from anyone's mind.

On a more pragmatic level, the Leegin decision is the continuation of a line of recent Supreme Court decisions seemingly demonstrating an overall hostility to plaintiffs in cases that may subject businesses to complex and protracted suits that are expensive to defend. Notably, the majority in Leegin appeared unconcerned about a plaintiff's difficulty and expense in proving a rule of reason case, and instead criticized the prior per se rule of illegality for resulting in meritless law suits instituted for their settlement value. In mandating application of the rule of reason, however, the decision almost certainly increases the workload of the lower courts, which can no longer rely upon a bright-line (at least, once an agreement was found) test. The Twombly decision already has been cited hundreds of times at the district court level, including many non-antitrust cases, as judges struggle with questions like "What alleged facts are sufficient to withstand the motion to dismiss?" and "Is the conspiracy alleged in the pleading a plausible one?" It remains to be seen whether a coherent set of rules or safe harbors for minimum RPM emerge from judicial opinions and jury verdicts attempting to balance pro-competitive and anti-competitive effects - let alone what the effect will be in the states, which are permitted to prohibit practices under their antitrust laws that may be lawful under the Sherman Act.

Next month, the author and his partner Fiona Schaeffer review the potential business implications of the Leegin decision and the future of RPM in the United States and overseas.

Scott Martin is a Partner of Weil Gotshal & Manges, resident in the New York office, and a member of the Antitrust and Complex Commercial Litigation practice groups of the firm's Litigation & Regulatory Department.